Like any global central bank, the Reserve Bank of India (RBI) sets the policy repo rate with a keen eye on evolving global economic and financial conditions, and the outlook for the economy. Balancing the two resulted in the RBI adopting a more cautious stance in its second bi-monthly monetary policy decision in FY17.
Indeed, it can be argued that there was a compelling case to lower the policy rate amidst a favourable monsoon outlook, the government’s progressive reforms and fiscal consolidation, and the need to accelerate more broad based growth.
While the GDP growth momentum did show an improvement in Q4 of the last fiscal year, the recovery has been patchy, with only a handful of lead indicators driving the upside. But, the sharper than anticipated uptick in April CPI inflation along with stickiness in household’s inflation expectations in May appears to have played a dampener, tipping the RBI’s decision in favour of a status quo.
Global developments since the last policy have also not been inconsequential – the Fed policy overhang, upcoming Brexit vote, along with firming of crude oil prices to close to $50 per barrel may have impacted some comfort additionally.
Nevertheless, the ‘wait and watch’ stance provides the RBI an assessment window for its easy liquidity policy introduced in April.
I foresee the RBI’s cautious stance giving way to accommodative actions in its next meeting in August. The space to deliver a rate cut of at least 50 bps will open up because of:
•An above normal and well distributed rainfall will support agriculture output and rural demand while imparting significant disinflationary impulses.
•Astute management of food economy by the government, having already begun with restrained hikes in MSP for FY17; this is going to be essential given the potential upside food inflation risks.
•Progress of the government on pending reforms and lagged impact of past reforms getting more entrenched in the economy. The stage is set for the government to further build on the transformational steps it has already taken to improve governance, ease of doing business and bring in key structural and banking reforms.
•The need to front load rate cuts to spur private investments, amidst a revival in growth impulses led by a healthy mix of urban and rural consumption along with higher quality public sector capital expenditure. As consumption-led recovery gains a stronger foothold, it will pave the way for a sustainable turnaround in investments and capital formation in the coming quarters.
The RBI’s cautious stance is indeed pragmatic against the backdrop of the uncertainty that is creeping in on the retail inflation front, and a lot will depend on the monsoon. In the meantime, stakeholders can derive comfort from the RBI’s assertion that its monetary policy stance remains accommodative. The economy’s wheels are moving again and need at least a 50 bps repo reduction lubrication in FY17.
The government will continue to drive growth by accelerating reforms, while the subdued appetite for fresh investment will be offset by higher public sector capital expenditure and a sustained improvement in consumption demand.
Rana Kapoor is MD and CEO, YES BANK, and chairman, YES Institute
The views expressed are personal